In recent years, consumption or usage (vs subscription) based business models have proliferated in existence as more and more customers demand value and flexibility from their vendors. This trend is easiest to observe in cloud-based software infrastructure companies like Snowflake, Databricks, MongoDB and Confluent - all of whom have implemented the consumption-based model for their cloud product and services.
Before we dig deeper, let us define key terms:
Consumption model: Customers are charged based on their actual usage or consumption of a product or service. Pricing structure is usually variable and customers have flexibility to pay for only what they use. Popular in cloud computing, pay as you go services and on-demand platforms
Subscription model: Customers sign an upfront contract to pay a recurring fee at regular intervals (e.g., monthly, annually) to access a product or service. Pricing is generally fixed, irrespective of usage, and customers have access to the offering as long as they maintain their subscription. Popular in SaaS services since it provides greater predictability of revenue
In this article, I will share best practices that companies need to adopt as they look to build consumption based model in their organization. I will frequently refer to examples from cloud based SaaS world since that is where consumption models are becoming most prevalent.
- Product features require ‘end-user’ and consumption focus
In traditional subscription based models, most of the product feature development effort is focused on winning traditional decision makers e.g., senior leadership, Info-sec & Security leads. For large enterprises, this generally means focus (outside of core functionality) is on building security, compliance and networking features - many of which are table stakes without which a product is not approved for use. There is generally less emphasis on meeting core product needs of the ‘end-user’. As a result, features that promote ease of use and rapid adoption are frequently de-prioritized.
Consumption completely changes this equation. Since revenue is not recognized until a customer utilizes the product, a different mindset is required. On the product side, features that allow ease of consumption need to be part of core product build. For instance, an important customer requirement from infrastructure service providers is to ensure their product can elastically scale from 0 to potentially a very high throughput depending on customer needs. This functionality allows customers to manage spend efficiently based on their usage patterns. In addition, features that allow customers to understand and optimize their product usage or provide them visibility to real-time expenditure are critical and give them confidence to scale up their spend on consumption models.
- Pricing needs to be usage based
As noted earlier, pricing is one of the biggest differentiators between subscription and consumption models. Typical cloud based SaaS companies, say Salesforce or LinkedIn, charge users recurrently based upon access on a per seat basis. Expansion means either selling additional products or adding more seats. This proved to be an excellent model financially due to its predictability and repeatability. There are however two drawbacks to this model:
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First, customers started to suspect that the subscription pricing was not well correlated with value. For e.g., people used products like LinkedIn recruiter more heavily when recruiting for a candidate than otherwise.
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Second, with the rise of Data-as-a-Service or Infrastructure-as-a-Service business models, the unit of value became data or compute, which is easier to track in terms of consumption. Both of these factors made the consumption model much more attractive.
Consumption based businesses charge companies on a unit basis e.g., per usage hour, per transaction or per volume of data consumed/stored/computed. In lieu of discounts, customers agree for fixed length contracts. In this model, the ability to predict and correctly adjust pricing based on future consumption patterns is extremely important. Since pricing is based on unit of consumption (e.g., data), product features or integrations that allow customers to consume more data or throughput become the most important requirements.
- Evolve GTM Roles to drive consumption
The need to drive consumption requires a very different mindset throughout the organization be it sales, marketing, finance or product. However, no topic raises more questions than the impact of the consumption model on the traditional GTM pod with its blend of pre-sales and post-sales roles working in tandem with the account executive to drive sales. Every traditional SaaS GTM organization invests in a pod that consists of the following roles -
- ‘Hunter’ or account executive (AE) who is accountable for bringing in new business
- ‘Farmer’ who is accountable for expansion in existing accounts
- Support roles - like technical pre-sales engineers, customer success managers, professional services resources etc., that partner with the AE to generate revenue
Most GTM organizations are looking for ways to optimize productivity and efficiencies across different customer segments by adjusting ratios of different support functions in comparison to quota carrying functions
Focus on consumption (vs subscription) changes the above model in fundamental ways:
- First, in a consumption world, the upfront contract does not yield revenue unless the customer starts consuming. Depending on the product & segment, this could mean a lot of work identifying appropriate use cases and pulling in the right support resources to ensure consumption. This leads to accountability issues in traditional hunter/farmer model. One way to solve this and break down silos between ‘hunters’ and ‘farmers’ is by making a single person accountable for upfront contract negotiation plus actual consumption during the course of the contract.
- Second, companies are rethinking the role of customer success managers (CSMs). In the traditional subscription model, they would be incentivized on retention and/or expansion. However, in a consumption environment where accountability on actual consumption rests with the AE, the skill sets needed for customer success teams may not be relevant anymore. There are companies that have eliminated the role completely e.g., Snowflake; others are experimenting with transitioning them to be project managers or service professionals
- Role of professional services also changes in the consumption world. Traditionally, services have been seen as a cost center and the emphasis has been on providing small, higher value add services given the lower margin structure of service model. However, a lot of value services teams add is in unblocking or accelerating certain implementation details that are essential to increase consumption. This means relooking at services charter to focus on activities that directly contribute to increasing consumption and de-prioritizing the rest.
There are similar questions to be asked across other GTM functions e.g., demand generation, field marketing etc to ensure the functional charter is linked with the customer needs in a consumption based environment. Once an appropriate resourcing model has been defined, emphasis shifts to enablement so that the field teams can be trained and enabled in the new operating model.
- Restructure the incentive model
Most people who have run GTM organizations know that getting the right incentive structure to drive proper business outcomes is one of the most important tasks facing any leader.
Consumption based models make the task even harder. Sales compensation is one of the core ways (outside of bonus and equity) by which the incentive structure is driven. Key question every executive faces is how to drive the appropriate balance between incentivizing new business vs consumption of existing accounts. In a world, where accountability to drive both rests with different functions, the calculation is more straight-forward. But if (as we discussed in the above section), the preferred model is to make an AE accountable for consumption then a proper balance needs to be found to drive right outcomes.
In my experience, this balance varies with the customer segment since the effort required to translate contractual obligation into consumption differs by customer size and complexity. Typically for the SMB segment, with smaller customer size and lower organizational complexity it is easier to translate contractual obligation into consumption. On the other hand, for large strategic customers it might take a few months to put in place all the processes/systems to ramp the consumption up to the anticipated amount. Given the challenges involved, the best approach to reduce unwanted surprises is by being evolutionary and empirical in approach to drafting incentives for the GTM org.
- Focus on right partners
Focusing on right partners - System Integrators, Resellers, cloud service providers, OEMs etc has always been integral to grow a SaaS business especially once the business achieves a certain scale. A traditional subscription B2B company focuses on building partnerships with resellers or SIs like Accenture, TCS etc to bring new business. In a consumption world, this model requires a rethink.
As noted above, the most important activity in a consumption environment is to accelerate the ability to identify new use cases and facilitate their implementation which translates to an increase in consumption. This means partnering with companies critical to the modern architectural stack.
Done right, this would create positive network effects leading to higher consumption of data (or compute) thus increasing revenue. The emphasis in short, is not just on bringing new deals but to create an ecosystem or a joint architecture that increases consumption. This is an emerging field that has already led to big changes in how the industry operates - for instance, many open source based companies (Elastic, MongoDB) started by competing against CSPs like AWS, Azure etc with alternate offerings available on CSP platforms (think AWS’s Spark or managed Kafka offering) but have recently started cooperating since both parties understand that they stand to drive much greater benefit by driving overall consumption of the platform by allowing customers to consumer best products.
- Align metrics, systems & processes
Finally, let us discuss how the operating rhythm for a business is different in subscription vs consumption models. In a subscription model, the most important metric is ARR or Annual Recurring Revenue (Net retention, gross margin and ARR growth % are other key metrics to measure). The operating cadence is primarily structured to ensure a company meets quarterly and annual ARR targets.
Revenue recognition directly follows from ARR irrespective of whether the customer actually consumes the product or service. In a consumption model, revenue is directly tied to consumption of product or service within the financial timeframe e.g., quarter. This adds complexity since there is a need to forecast consumption and also operational requirement to monitor leading indicators of consumption at customers a few quarters out and take appropriate actions if there is a gap.
Top quartile companies build completely new systems and dashboards to track, forecast and report consumption by different customer cohorts and segments. Predictability can be much harder especially in case of fluctuating usage patterns and requires additional process or analytical rigor to ensure accuracy.
Finally
In conclusion, the rise of consumption led business models has created an opportunity to create products and services that are much better aligned with how customers derive value. However, to fully realize the potential of consumption motion, it is important to understand the nuances between subscription and consumption model. This will ensure the resources, metrics, and roles are structured appropriately to ensure success.